Political Economy of Public Pensions

The United States faces a significant funding crisis in public pensions due to the financial crisis and COVID-19 recession. This Element examines the political economy of public pensions, highlighting the knowledge and incentive problems inherent in their institutional structure, governance, and accounting. It offers reforms to address the crisis.

Format: Paperback / softback
Length: 75 pages
Publication date: 02 September 2021
Publisher: Cambridge University Press

The United States is facing a significant and imminent funding crisis in its public pension systems, stemming from the combined effects of the financial crisis and the COVID-19 recession. This crisis is expected to have far-reaching consequences for many cities and states, as they struggle to meet the growing obligations associated with these pension programs without significant cuts to government services, reneging on pension promises, or raising taxes.

To better understand the origins and dynamics of this pension funding crisis, this Element will examine the issue through the lens of political economy. We will analyze the knowledge and incentive problems inherent in the institutional structure, governance, and accounting of public pensions. By doing so, we hope to identify potential reforms that can help address this pressing issue.

The development of the pension funding crisis can be traced back to several factors, including the changing demographics of the workforce, rising healthcare costs, and economic downturns. As the baby boomer generation retires, the burden of providing retirement benefits to public employees has increased significantly, leading to concerns about the sustainability of these programs.

One of the key challenges facing public pensions is the lack of transparency and accountability in the institutional structure. Many pension systems are managed by state or local governments, which can introduce political biases and conflicts of interest. Additionally, the governance structure of these systems is often complex and opaque, making it difficult for stakeholders to understand how decisions are made and how funds are allocated.

Another issue is the incentive structure of public pensions. In many cases, pension benefits are based on a formula that links the final salary of an employee to their years of service, which can create perverse incentives for employees to work longer than they may need or want to. This can lead to increased costs for the pension system and potential financial instability.

Accounting practices also play a role in the pension funding crisis. Many pension systems use actuarial assumptions that may not be realistic or up-to-date, which can underestimate the true financial burden of these programs. This can lead to underfunding and potential risks to the stability of the pension system.

To address the pension funding crisis, there are several institutional, governance, and reporting reforms that can be implemented. One potential reform is to increase transparency and accountability in the institutional structure of public pensions. This could involve creating independent oversight bodies to manage these systems and ensure that decisions are made in the best interests of retirees and taxpayers.

Another reform is to reform the incentive structure of public pensions. This could involve moving towards a defined contribution pension system, where employees contribute a set percentage of their salary to their retirement account, rather than relying on a formula that links their final salary to their years of service. This could help reduce the financial burden on the pension system and encourage employees to work more efficiently.

In addition, accounting practices should be reformed to ensure that actuarial assumptions are realistic and up-to-date. This could involve using more sophisticated modeling techniques and engaging independent actuaries to review and validate these assumptions.

Finally, it is important to increase public awareness and education about public pensions. This could involve providing more information about these programs to employees and retirees, as well as promoting greater engagement and participation in the governance of these systems.

In conclusion, the pension funding crisis in the United States is a significant and imminent issue that requires urgent attention. By examining the issue through the lens of political economy and identifying potential reforms, we can work towards ensuring that public pensions remain sustainable and secure for generations to come.

Weight: 140g
Dimension: 151 x 228 x 9 (mm)
ISBN-13: 9781009011624